Dividends are often viewed as just a perk of owning ASX shares, but history tells us that dividends are a larger part of generating stock market wealth than this view indicates.
If you take a holistic view of total ASX 200 sharemarket returns over a long period of time, more than half have come from the dividends paid out from ASX companies.
How do dividends contribute to wealth?
If you want proof, take an ASX200-tracking index fund like the SPDR S&P/ASX 200 Fund (ASX: STW). According to the SPDR website, STW has returned 8.18% per year on average since its inception in 2001. Of that 8.18%, only 3.46% has come from capital growth (share prices rising), with the remaining 4.72% stemming from dividend distributions.
So, if you invest $20,00 a year into a simple index fund like STW (assuming you can continue to get a similar return) and reinvest your dividends to add to the compounding effects, it will take 20 years to reach the princely sum of $1 million – even though you'll only have deposited $420,000 of your own cash. If you extend this to 30 years, you're looking at $2.5 million, with only $600,000 of your own money deposited.
All this is just using a simple, market-wide ETF. If you manage to pick a few winning dividend growth stocks, you could be looking at a much higher rate of return. Companies that come to mind include Macquarie Group Ltd (ASX: MQG), CSL Limited (ASX: CSL), Premier Investments Ltd (ASX: PMV) and Ramsay Health Care Limited (ASX: RHC).
Are there any wealth risks with dividends?
Of course, some dividend stocks do run out of steam. There's no doubt that anyone who bought Commonwealth Bank of Australia (ASX: CBA) shares when they floated in 1991 for $5.40 per share would be sitting very happy today (with a huge chunk of both capital gains and growing dividends).
However, with CommBank's size and the threats facing the ASX banks today, I'm not too sure CBA shares have the potential for delivering the same kinds of growth over the next 28 years as the last.
Foolish takeaway
Dividends are a wonderful way of harnessing compound interest to work in your favour. Most ASX companies pay solid dividends combined with various levels of franking – giving any investor the opportunity to build up a rich portfolio of income-paying shares over their lifetime.
In my opinion, the keys to getting rich and wealthy through dividends are time and patience (it's that simple).
